Badger Meter Inc (BMI) 2017 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q3 2017 Badger Meter Earnings Conference Call.

(Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

It is now my pleasure to hand the conference over to Mr. Rick Johnson, Senior Vice President of Finance and Chief Financial Officer.

Sir, you may begin.

Thank you very much, Brian.

Good morning, everyone.

Welcome to Badger Meter's third quarter conference call.

I want to thank all of you for joining us.

As usual, I'll begin by stating that we will make a number of forward-looking statements on our call today.

Certain statements contained in this presentation, as well as other information provided from time to time by the company or its employees, may contain forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from those in these forward-looking statements.

Please see yesterday's earnings release for a list of words or expressions that identify such statements and the associated risk factors.

Let me reiterate some of our guidelines.

For competitive reasons, we do not comment on specific individual product line profitability, other than in general terms, nor do we disclose components of cost of sales, for example, copper.

More importantly, we continue our practice of not providing specific guidance on future earnings.

We believe specific guidance does not serve the long-term interest of our shareholders.

Now on to the results.

After the market closed yesterday, we released our third quarter 2017 results.

While the bottom line did not match our expectations, sales were a record for any third quarter at just over $100 million.

This is an increase of $3.7 million or 3.9% over last year's third quarter sales of $96.3 million.

Let's talk about some of the details.

Municipal water sales represented 74.7% of total third quarter sales compared to 77.4% in the third quarter last year.

Municipal water sales increased 0.3% to $74.7 million in the third quarter from $74.5 million last year.

This is the net impact of higher commercial water meter sales and the inclusion of about $800,000 of sales from D-Flow, which we acquired earlier this year, offset somewhat by lower sales of residential meters and related technologies.

Some of the decline in residential sales was due to lower international sales, particularly in the Middle East where, as we've indicated in the past, sales tend to be sporadic.

Flow Instrumentation products represented 25.3% of total sales for the third quarter compared to 22.6% last year.

Sales increased $3.5 million or 16.1% to $25.3 million from $21.8 million last year.

We saw significant increases across most of our product lines, including meters for the oil and gas market, valves and magnetic meters.

Gross profit as a percentage of sales was 37% in the third quarter compared to 40.1% in the third quarter of 2016.

The primary driver for this decrease was higher brass and other costs compared to the same period last year, which contributed to the lower overall gross margin and lower earnings.

Our selling, engineering and administration expenses for the third quarter decreased slightly to $24.6 million from $24.7 million.

You will recall that last year's third quarter expenses included approximately $740,000 of a noncash pension settlement charge that did not recur this year.

This year's expenses do include costs associated with D-Flow.

The provision for income taxes as a percentage of earnings before income taxes for the third quarter was 34.5% compared to 36% in the third quarter of last year.

The effective tax rate on an annual basis is now estimated to be 35.3%, plus or minus any minor discreet items.

Early in the year, we were using 35.5%, so the effective tax rate for the quarter is lower as we adjust year-to-date.

As a result of the items I just mentioned, net earnings for the third quarter of 2017 were nearly $8 million or $0.27 per diluted share compared to $8.8 million or $0.30 per diluted share in the third quarter of 2016.

Our financial condition remains strong.

For the 9 months ending September 30, we generated $45.9 million in cash from operations compared to $40.2 million in the same period in 2016.

Debt as a percent of total capitalization stood at 14.1% on September 30, 2017.

With that bit of background, I will now turn the call over to Rich Meeusen, Badger Meter's Chairman, President and CEO, who will have some additional comments.

Rich?

Thank you, Rick, and thank all of you for joining us today.

This was an interesting quarter for us with record sales but low earnings, as Rick discussed.

Although utility metering sales were relatively flat, we have seen an overall softening in the utility market over the past 6 months.

When several of our competitors reported their second quarter results, they had significant decreases in sales.

Therefore, we feel good that we've been able to hold our own position and most likely have seen an increase in our market share.

In addition, we continue to see significant increases in our sales of our newer products, both the E-Series Ultrasonic meters and the ORION Cellular radios.

We are currently working to integrate the technology of our recent acquisition, D-Flow, into our Ultrasonic meters and expect that that project will be completed later next year.

Also the introduction earlier this year of the LTE version of the ORION Cellular radio has driven a lot of interest in this leading-edge technology, resulting in many utilities initiating pilot tests, which we expect will further increase sales in 2018.

We saw a significant rebound in our Flow Instrumentation business, driven both by continued improvement in the oil and gas markets as well as the impacts of sales channel reorganizations that we completed over the past year.

Our recently announced distribution agreement with DNOW L.P. for our global sales into the oil and gas industry did not have any significant impact on this quarter, but is expected to drive even more growth in future periods.

Margins were softer than usual this quarter, primarily due to a significant impact from copper prices.

In the third quarter of last year, copper averaged $2.16 per pound, but increased 35% over the past year to average $2.91 per pound during the third quarter.

We purchased a substantial amount of brass for our meter manufacturing, which is primarily composed of copper.

Since September 30, copper prices have continued to increase to well over $3 per pound, however, most commodity analysts believe this pricing level is not sustainable, and they expect to see price decreases going into 2018.

Nevertheless, we are prepared to announce price increases to offset higher material costs as well as expected price increases in resin due to the impacts of Hurricane Harvey on resin producers in the Houston area.

These increases will be announced in the fourth quarter, but will not have any impact until the first quarter of 2018.

It should be noted that when copper prices have jumped in past years, our industry has generally been successful in passing along pricing to offset those increases.

We see no reason to expect it to be different in the future.

Overall, we continue to be confident about the future of our business and our ability to generate shareholder value on a long-term basis.

With those comments, we'd like to take your questions.

(Operator Instructions) And your first question will come from the line of Nathan Jones with Stifel.

Rich, I wondered if you could give us a little more details on the planned price increases in the fourth quarter.

Do you think they're going to cover all of the raw material increases?

Do you think there'll be a lag to that past the first quarter?

Or just how should we think about that price cost dynamic for you guys over the next few quarters?

Yes.

What we will do is, over the next 30 days, we'll go through and queue up that increase.

We need to give our distributors and certain customers notice, at least 30 days notice, if not more.

So over the next 30 days, we'll go through and figure out which products, how much and adjust our pricing sheets.

All of that will be effective January 1. That's our target.

Now our -- now, obviously, over the next 30 days, we're going to be watching the cost of copper, too.

This morning it's at $3.17.

So it's jumped again on the London Exchange last night.

A lot of that increase is being driven by news out of China.

The problem we all have with China is we don't know how much copper they have in their stocks over there.

They don't release -- they don't announce that, so they are always the wildcard.

So what went up so quickly in the last few weeks could also go down just as quickly.

So we're going to be watching that and adjusting that increase for whatever happens with the price of copper.

But we are shooting at a moving target.

Yes.

And the other thing, Nathan, is while we announce it -- we'll announce it in the fourth quarter, we could get orders yet in under the old prices for delivery in the first quarter.

So to your point, there could be a bit of a lag where it really doesn't fully kick in until the second quarter.

Yes.

Generally, in the past, we have announced a price increase and obviously, we have contracts.

We don't do contracts for more than a year at a fixed price.

If they go beyond a year, we've got a consumer -- a producer price index adjustment in them.

But we have contracts that will be coming up for renewal every month over the next year.

And as they come up for renewal, we'll factor in those price increases.

The ones that have our PPI adjustments, we'll factor those in as soon as we can.

But then any new contracts will be led at new prices.

So unfortunately, it does take a ramp-up.

If we target an overall dollar amount that we're after to offset the impact of brass, it takes us a while to get there.

On the positive side, we also gain on the downside.

If brass starts coming down again, it takes a while for that pricing to adjust down from competitive pressure, and so we gain on there.

So just like when brass hit or when copper hit $4 a pound several years ago, and we went out and put in price increases to offset that, we expect this to follow along the same guidelines here.

So there may be some short-term negative impact, but we will get it in there.

Okay.

So it sounds like a couple quarters of margin headwind there.

I understand that this is not the way to go, but if we assume that copper was flat from here, would you think that by, say, the second quarter of next year that you would be -- you would have recaptured all of that price cost differential?

That would be our goal, yes.

Okay.

You did mention in the press release that there were some other expenses in there that also dragged down gross margin.

Were they related to the acquisition or were they onetime in nature?

And any color you can give us on the size of that.

Yes.

This is Rick.

I would think for the most part they were onetime in nature.

And just -- and frankly, just higher than last year.

You also got to remember, our comp last year, the gross profit percentage was 40.1%, but that's a little bit higher than normal.

So I mean when we say higher cost -- higher than last year just simply because of that fact.

Okay.

So any color you can give us on the magnitude of that?

Most of the decrease in gross profit percentage was driven by the copper.

I mean most of this other stuff was $100,000 here, $100,000 there, nothing of substance.

Except we did have a significant payment to a search firm for our new COO that we hired.

So...

That's not in the margin.

No, it's not in the margin, but it's down in the -- I'm sorry, it's down in the SG&A costs, but that was in there, too.

And your next question will come from the line of Tate Sullivan with Sidoti.

Can you follow up your comment on some softening in the market?

I mean, historically, what's that due to?

Is it due to multiple areas being done with their replacement cycle, replacing their older meters?

Or what are the current factors and that's all...

No, what we're seeing right now is some of the larger projects that were in the queue are getting pushed out, delayed.

And it's always a question as to what causes this, we have to go out in the field to get anecdotal evidence.

In some cases, it's all this talk out of DC about a possible infrastructure bill.

And people are saying, "Well, maybe they'll be some federal money that will help, and so we're going to delay a project." So we're hearing some of that talk out in the field.

But generally, we know our competitors are hearing it too because if you go back to the second quarter conference calls, from the competitors who disclose the water portion of their business, and there's 3 major ones out there that do that are public, they all said that they were down anywhere from 5% to 13%.

So when we saw that we were relatively flat, that's why I felt like we were probably gaining a little bit of share.

But there have been delays.

I have no reason to believe any projects have been canceled.

They'll still come.

The question is, will we get them in the fourth quarter or the first quarter.

And the other thing we're seeing, Tate, is if you recall at the end of the second quarter, we had just introduced the -- effectively, the LTE product, all right?

And what we're finding is, is while there's very much interest in there, people are not -- they're not buying thousands of them.

They're buying 100 of them and putting them on tests.

We're seeing a lot more pilots right now.

It's in a sense -- in our mind, it's just delaying sales.

So I think -- and I do agree with Rich.

There's nothing fundamental out there that suggests as a reason for this.

It's just kind of a bland year, and it's been a bland year through 3 quarters.

Okay.

And then I thought you mentioned valves in your comments.

Yes.

And is that valves that go with meters in your industrial business?

Or what valve business do you have in your modeling?

In our Flow Instrumentation side of our business, which is about 20% to 25% of our business, which, by the way, was up 16% over last year, so it was a good increase.

I read that.

Yes, I know you read that.

I'm just repeating it.

Well, I'm listening.

Okay.

So in that -- within that business, one piece of it is valves.

We also do vortex meters.

We also do turbine meters, Coriolis mass meters, mag meters.

So there's a lot of other ones in there, but one piece of it is valves.

It is the one thing that is not directly flow measurement, but it's a good business for us, it's profitable and we do link the valves up with meters sometimes to form a complete control loop.

But that business itself, our valve business, is -- thank you, John.

It's being handed to me.

Yes, for the quarter, it was about...

Our valve business is about $3.5 million a quarter, so it's about $14 million a year.

Okay.

And then on -- to follow up the brass -- the copper comments and the brass, do your Ultrasonic meters even use brass compared to the older meters?

Our E-Series Ultrasonic meters are offered in both plastic and stainless steel, okay?

We will be converting them and offering them in brass.

We initially came out with them in stainless steel because stainless steel was actually the same price as brass, and we felt that the market would be willing to pay a premium to have stainless steel, which is viewed as an even better material.

What we found out is that the market really doesn't care whether it's brass or stainless steel.

They just want metal.

So we started a project to develop in brass.

Now if brass gets too expensive, then the stainless steel is a better option.

But right now, they are offered only in stainless steel.

But you have to remember that all of our large meters, all of our large meters are in brass and that -- those are the ones that take up a large quantity of brass.

And our next question will come from the line of John Quealy with Canaccord.

First question, Rich or Rick, can you break out mechanical versus AMR/AMI?

And any third-party Itron color you can give us?

So you're talking about meters without radios versus meters with radios?

Exactly.

That's right, Richard.

And I'm just looking at this.

That's a hard one to see.

Let's find answers this way.

I mean, we have settled -- I mean, basically, it's the same underlying meter either way, with or without the radios.

We've been saying that we're shipping 60%, 65% on average of the meters that we're shipping have radios, okay?

Now that varies quarter-to-quarter depending upon the particular product, that's why I think Rich was kind of hesitating a little as he looks over all these details.

But that number continues to grow.

The installed base out in the field is probably about 55% of the meters out there have radios.

And if we keep having an input rate that's approaching, let's say, 55%, that number will continue to grow.

It's just a matter of how fast that's going to grow.

Okay.

I'll do 2 more.

So Rich, would love your thoughts on Itron/Silver Spring pushes them more electricity, more IoT.

What do you think that does to market share, name share in the U.S. radio, AMR/AMI market for water, if anything?

Yes.

Silver Spring did not play heavily in water.

They were really much more of an electric-focused company.

And obviously, Itron, the majority of their business is electric.

That is where their big focus is.

We focus only on water.

So we didn't see the purchase of Silver Spring as having a huge impact on the competitive market out there on the water side.

I think it does have an impact on the electric side, but it -- we don't really see this having a big impact on water.

Okay.

And then last.

So the creation of the COO role, and welcome, you guys have run a pretty great business over a number of years.

Why now, Rich?

And what should we think about leadership transition, if that's part of this?

Well, no.

That's a good question.

And we do have Ken Bockhorst sitting here, who is our new COO, who has just -- I believe, it's his second day of work.

So welcome, Ken.

And when I mentioned that we paid a lot of money for a search firm, it was the best money we ever spent -- and he agrees.

So we're excited to have Ken joining us.

The fact of the matter is, I am 62 years old and Rick is older, slightly older.

And so we recognized that over the next couple of years, we're going to have to have a shift in leadership here.

The good thing is that the officer team that has driven this company for the past 10 years to where it is today is very stable and is here and is going to continue.

It's a younger team.

Younger, meaning in their early 50s.

So we're going to have them around a while.

But bringing in Ken helps us set up the transition for down the road.

So this has been something that the Board of Directors has been working on for the past several years.

We ran a formal search.

We were fortunate to get somebody of Ken's caliber in here.

And now we will be -- he will take on that COO role and hopefully be moving up as we go forward.

But it will give us plenty of time for overlap to make sure that he and other people are comfortable with this management team as we go forward.

We will be bringing Ken out for investor meetings, so all of the analysts, investors will have a chance to meet Ken and talk to him.

And I think you're going to find out that his operating style, his vision very much fits with Badger Meter.

One of the things that I think you're going to -- we're going to be looking for is getting a little more aggressive in M&A, and that is one of Ken's strong points, so that's going to help us, too.

So I hope that all helps.

Our next question will come from the line of Brian Rafn with Morgan Dempsey.

You guys, I think, and correct me if I'm wrong, launched the ORION Cellular, the LTE 2-way in July or it was in the second quarter.

Is there any pent-up demand in delays on orders?

Or is there in subsequent quarters or is it just going to kind of roll out with pilots?

So just to clarify, Brian, we launched the ORION Cellular about 3 years ago as a 3G product and simply because the LTE networks weren't available for data yet.

The LTE chips for data became available late last year.

We immediately launched a project to move to the LTE platform, and that new version, with the LTE chips, was released in April.

So I do believe we saw a little bit of a delay, people waiting for the LTE, and I still think there is some pent-up demand because we're getting a lot of inquiries, we're doing a lot of pilot shipping of people who were waiting for the LTE, but they didn't come in as soon as the LTE was released and say, "Now give me 10,000."

Instead, they said, "Give me 50 or 30, and we'll put them out there and try them for a few months and make sure they work okay before we commit to larger volumes." I'm still convinced that this is going to be the technology of the future for our industry because the whole idea of not having all that infrastructure makes so much sense that I think people are going to want to go this way.

Yes.

With some 51,000 water meter -- or water utilities, are these test pilot programs in the hundreds of utility OEMs?

Or is it just dozens?

Or what's...

No.

No.

No, it's hundreds.

It's hundreds.

So we believe it bodes well for future demand.

I think we're going to continue to see that.

I think we're going to continue to see our 2 fastest growing products, being the E-Series water meters, the Ultrasonic water meters, especially once we finish integrating the D-Flow Technology next year, which will make the product even more competitive with the mechanical meters.

It's going -- we're going to see that.

And then on the radios, we're going to see cellular.

And both of them, we have seen since introduction, strong double-digit growth every year, and I think we're going to continue to see that.

Got you.

Got you.

Rich, you -- the question on mechanical versus AMR/AMI, I think in your presentation in August, you guys got an installed base of about 58% meters with radios.

And I think Rich's comment was your -- or the actual delivery now is more like 60% to 65%.

If I were to add on the BEACON Advanced Meter Analytics, you guys kind of being a leader in that, what might that be?

Would that be still less than 1% or 2%?

How fast is that add on that adjunct of technology being put on with the radios?

The BEACON is also coming on fast.

And it's coming on fast in 2 ways: one is that when somebody buys cellular, okay, and I'm looking for Kim to look at me to make sure I'm -- okay, my VP of Sales, I always like her to be staring at me when I'm saying this so that if I say the wrong thing, she can frown.

But I think I'm right on this.

The BEACON is sold with the cellular product and...

And the network.

Right.

I'm saying, first, it's sold with all of the cellular but -- and some of our network customers and even some of our drive-by customers have said, "We want to have BEACON analytics, too." So we've got it being sold across a much broader base than just the cellular.

So as cellular goes up, so does BEACON, but then we're also picking up these other customers, too.

I would say, in a few years, we're going to be able to phase out some of our older -- our legacy products and focus much more on the BEACON as our main product.

The nice thing, too, is that with the cellular, obviously, we gather monthly fees, okay?

And even with the BEACON product, there are annual fees that we get from that.

So as we've always said in the past, we are not driving towards Software-as-a-Service as a company.

But it is becoming more and more of our revenue stream as we go forward.

Got you.

Got you.

I'll just ask one more, Rich.

As I'm looking at your market share chart here in your presentation, North American water, you guys are very quickly catching Neptune.

Do you have any comment and kind of that top-tier oligopoly Neptune, Sensus and Badger Meter kind of where you might see that go over the next few years?

Yes.

And you guys always love me to talk about the competition, so I won't disappoint.

I'll make a few comments here.

First off, market share is very difficult in our industry because if you add up everybody's claimed market share, you get to about 120%, so not everybody's being honest on their market share.

And the analysts that do market share analysis, I don't think always get the facts right.

What I would say is we have...

Present company excluded, of course.

Present company excluded.

No, I'm talking about the companies that sell the service of analyzing market share.

But I would say that Badger and Neptune both have a market share that is very close.

So we're probably the 2 top companies as far as selling the meters in North America.

Sensus is somewhere below us and then down you've got less than that at Mueller and Master Meter and some of these other smaller players in the marketplace.

Neptune has been a little slow on new product introduction, but now they have announced a cellular product.

So they're 3 years behind us on that.

But they are coming out with cellular.

And I'm kind of glad of that because it does confirm that cellular is a good product going in the future.

We're not the only ones out there with it.

They've also announced an ultrasonic meter, and they're going to be starting to sell that.

So again, that validates our ultrasonic technology when the 2 leading companies in the marketplace are selling that technology.

Sensus does not have cellular, has not chosen to go cellular.

They are still selling their fixed network called FlexNet, and they have chosen magnetic meter as their solid-state metering.

I think there are issues with magnetic that will make ultrasonic more competitive in the future.

And meanwhile, Mueller does not have a either cellular or a solid-state meter.

And so basically, when you look at the competitive situation, that's where we are.

We feel we're in the strongest competitive situation, having been in the ultrasonic metering business for 7 years and the cellular business for 3 years, while our largest competitor is just starting this year on both of those.

I think that puts us in a very strong position.

And our next question will come from the line of Richard Eastman with Robert W. Baird.

I wanted to ask [Ken] a couple of things -- No, I'm just kidding.

Just, Rick, I just want to wake him up actually.

Just from a municipal standpoint, I think the reference was that the international business was lower.

I think you specifically mentioned Middle East.

But if you look at the utility business, was the domestic residential business up low single digits, mid single digits?

How did the domestic business perform there?

This is Rick.

The domestic -- the municipal water business was essentially flat Q3 over Q3.

Okay.

Okay.

And then does that include the commercial piece?

Was the commercial meters up?

Commercial was up.

Okay.

Okay.

Low singles, is that close enough?

Yes, that's fine.

Okay.

Okay.

And then just a question around -- late in the quarter, any hurricane impact more on the industry?

I know both in the Houston market, but more so in the Florida market, I think your exposure in Florida is somewhat limited at Badger.

But was there any cramping up in the industry in terms of demand installed?

I mean, what's your thought, Rich, on the impact there?

I mean, when we had Sandy, it kind of held up spend.

So maybe just any thoughts there.

Yes.

I do think there's some impact.

Fortunately, we did not have a major project going on in Houston.

We didn't have a major project going on in Miami or anything like that.

Nobody did.

So I -- so there was not a major project where somebody was selling $1 million of ordering meters that got interrupted.

In the case of Sandy, it did.

We had some large projects going on in that area.

And when that hurricane came through, it was a big impact.

Now we do have regular meter sales to those -- to not only Houston, but the area around it.

No question, it got interrupted.

And...

But I would say it didn't have a profound third quarter impact.

If anything, we're still waiting to see if it's going to have an impact in the fourth quarter.

But then, likely that would rebound in the first quarter if it did happen.

And the other impact of it, Rick, is as I mentioned briefly was resin.

We don't buy our resin out of the Houston area, but most of our resin suppliers get their feedstock out of the Houston refineries.

And so there was an interruption there.

We don't think we're going to have a supply issue, but prices may take a temporary jump.

Again, we're going to factor that into our price increasing.

Okay.

And just -- your reference on the large projects, is that -- large projects kind of stalling out a bit?

Is that a domestic comment?

I mean, is that around large projects domestically?

Or is this again kind of international and...

No, that was a domestic comment.

Okay, so it was domestic.

Okay.

Right.

The opportunities we have in the Middle East are very spotty, very project related when one of the emirates or somebody will decide to do a major project.

So that's more project related.

Yes.

I was curious.

As the state of Illinois kind of mandate -- I think this was during the third quarter, certainly earlier this year.

They kind of mandated that municipalities have to ensure that they have no more than like 10% [unaccountable for] water by 2019.

And there was a project triggered there.

And I -- not to be too surgical here, but you guys have some exposure to Illinois, to the Midwest.

Is that either a trend or is that at all impactful, if [they are starting] to tighten up on this unaccounted for water?

Right.

Clearly, everybody wants to tighten up on unaccounted for water.

The question is do they have the political will to do it.

You may recall that we were metering Chicago, we got it 1/3 metered.

People are surprised to hear the City of Chicago is not fully metered.

About 2/3 of the people in Chicago pay a flat rate for their water.

Therefore, you will never know if there's unaccounted water there.

They'll never be able to track it down.

So -- and under Mayor Daley they were -- they had a metering program and when Rahm Emanuel came in, he stopped the metering program.

So 2/3 of Chicago still sits unmetered.

Now when they get a state mandate like that, obviously, the first thing you would have to do is meter if you're going to try to reduce unaccounted for water because you can't control what you can't measure.

If they can't measure it, they don't even know what their percentage is.

And that's a problem.

So that would say that more of the Illinois municipalities should start metering.

The question really is, Rick, what penalties were put in.

It's very easy for the legislature to pass a law saying, "Let's hit this target by 2019," but if there's no penalties, it doesn't mean anything.

The California...

I was going to bring up California.

California has a law on the books that by 2025 every home in California will have a water meter.

So as I say, look for big sales in 2024 because they didn't fund it.

They didn't fund it.

It was an unfunded mandate.

It's those kind of issues that when you hear that stuff, it doesn't have an immediate impact on our business.

Although, again, when I heard about Illinois, it can't hurt.

That's fair.

Yes.

Yes.

Fair enough.

Hey, Rick, just one last question.

When I look at both accounts receivables and inventories, inventories stepped up in the second quarter from the first.

But then, stepped up again in the third by about $3 million and then AR kind of stepped up another $4.5 million.

Just given where the sales number came in, can you just explain maybe why AR stepped up as well as inventories?

Yes, it was simple.

September was better than July and August, okay?

And it's -- our DSO is up slightly but there's really no significant collection issues.

It's more a function of timing than anything else.

And quite frankly, the same thing on inventory.

There's really nothing that suggests that there's any issues one way or another.

The other problem we have in our...

[Any change in] terms or anything?

No, we haven't changed any of the distributor terms.

And our next question will come from the line of Hasan Doza with WAM.

A couple of questions.

Just to follow-up on the balance sheet.

If you look at your accounts payable year-over-year and this is excluding a $4 million from the D-Flow acquisition, your payables went from $19 million to $23 million.

This is including the $4 million in D-Flow.

That's a 20% increase while your sales are down year-over-year.

So I'm just curious, what's going on with the payables?

My first answer is I have no idea, but I'm not aware of any particular issues.

Are you comparing us to December 31?

No, I'm comparing you to third quarter of last year year-over-year.

Third quarter of last year.

It could be the function of the days when we paid the bill.

Well, that's right, and very often that's a function of what day of the week the month ends on because bills are usually processed on the Fridays, and so it's purely timing.

It's nothing more than timing.

I know you answered the question on receivables, but just to reiterate again.

I mean, when I look at year-over-year, third quarter of last year to third quarter this year, your receivables are up like 20%.

So I know you just -- I mean, is there something underneath you're seeing on a more longer-term basis?

No, there's -- I mean, frankly, is there a distributor or two instead of paying us in 30 days they're paying us in 45?

Yes.

We've got -- and there's some business issues at work here, but nothing that's of concern to us at this time.

Okay.

Okay.

And then my second question is, you referenced in the release that you're seeing some customers upgrade their system as they wait to adopt your cellular product.

Can you give some color as to what type of upgrades for example a customer would need to make and how much would it cost them for them to adopt your cell product?

No, I think you misunderstood what I said.

There is no requirement for a customer to upgrade their system in order to adopt our cell product.

If they adopt our cell product, they also use the software, the BEACON software that goes with it.

Just like if you were to buy a printer, you would probably use the printer driver that goes with it.

And the BEACON software, of course, comes with a lot of analytics and other capability.

But that's a very easy software to put in.

Now very often, though, some of these customers have home-grown billing systems and the BEACON software has to be mapped into their billing systems.

That can get a little tricky, but generally, there's no system upgrade they have to do in order to use the cellular system.

Okay.

Yes, I mean, I'm taking this straight out of the release, it says several major municipal water projects slated for the third quarter are now expected in the future as customers upgrade their systems.

That's...

Well, in other words, what we're saying is -- yes, that what we're saying is, they plan to upgrade their systems, so instead of placing the order now, they -- instead of buying, again, my example, instead of buying 1,000 meters, all right, they bought 100 and put them on test pilot just to see how they work.

And then eventually, they'll make the purchasing decision sometime in the future.

But Hasan, the reference to upgrading their system...

From what they bought 15 years ago.

Is not their IT system.

It's upgrading their system of meter reading.

Correct.

And we probably should have been clearer about that.

We're talking about their meter reading system, not their IT system.

(Operator Instructions) And our next question will come from the line of Jose Garza with Gabelli & Company.

Rich, I guess just kind of talking about the DNOW distribution, if you could just kind of give more color and then what kind of does that mean for your existing kind of oil and gas business?

And if there's any kind of other additional partnerships you're kind of looking for on the flow side, instrumentation side?

We -- yes, the Flow Instrumentation business, we go to market primarily through distribution.

And when I said we reorganized our distribution channels, what we did was we started focusing on the end markets instead of the products.

So we've, in the past, may have had a distributor who specialized in turbine meters and a distributor who specialized in impeller meters.

What we've done now is we've reorganized to where we have a distributor who perhaps specializes in breweries or a distributor who specializes in dairies or oil and gas.

So we -- I'm sorry.

And I'm using the word distributor, I apologize.

I just got a note, I should be using the word rep.

These are reps, not distributors.

These are primarily reps, okay?

So we have reps that now focus on various industries and specialize in those industries.

That has helped us a lot because now a rep goes in and can sell any type of meter that is needed in that particular industry, and that's a good thing.

It was a big coup for us, we feel, to get DNOW because we were going to the oil and gas market with a lot of smaller, more decentralized reps.

And DNOW is really a very large international -- they're an international company that services oil and gas markets all around the world.

And so having an agreement with them, where they are repping Badger's Flow Instrumentation products, I think is really going to open a lot more doors for us and help us get out there.

So that's what really DNOW does for us.

Yes.

And just remind me, is that an exclusive partnership?

That is outside of North America.

It is exclusive outside of North America.

Within North America, we have some other reps also.

Okay.

And for the rest of your business, I mean, in the Flow Instrumentation side, are there other opportunities that you guys are looking at that are, I guess, similar -- that would be similar to DNOW?

Yes, we're always looking at opportunities to improve distribution channels.

We have some distributors now that we'd picked up over the last year that we really like.

But there's always opportunities to find other ones that specialize in different areas, and we're going to be pursuing those.

And our next question will come from the line of Brian Rafn with Morgan Dempsey.

Rich, just kind of maybe a 5-year outlook relative to kind of the larger municipal national sales accounts.

Any big cities looking at projects that -- not for you, but just for the industry that might be...

Right.

Right.

There are some big cities out there that we've talked about in the past that will be -- that keep saying they're going to be looking at doing a major project.

They, from time to time, put out a request for information.

They may form a committee to look into it.

We're in those cities talking to them.

Miami-Dade is probably one of the big classic elephants out there.

They've not done anything, but they've run tests, they've run pilots.

So they're out there.

Detroit is talking about doing something new, so they're always a possibility.

There are other cities in -- some of the major cities in Ohio are opportunities for us.

So those are the ones that could still pop over the next several years that could be pretty big, pretty big game changers.

And it's important, clearly, from a sales and marketing side -- I keep being told to put up my mic.

I hope everybody can hear me -- but from a sales and marketing side.

But also, you've got to remember that they don't have the same impact on the business, let's say, that they do in the electric industry.

Because usually when we get those, they're multiyear contracts, okay, and they get spread out.

So even when we had Chicago now, what, 6, 7 years ago, it got spread out over 3 to 5 years, and it had an impact.

It's nice to have that steady order.

But you can also sell a lot of small cities the same amount of meters in a given year.

Also people tend to forget that the size of a city can be deceiving.

For example, a lot of people think Atlanta would be a huge customer, the City of Atlanta.

The City of Atlanta is only 300,000 people.

It's not that big a city.

It -- however, the surrounding area is huge, the metro area.

Well, when we're selling water meters, we're generally not selling to the metro area, we're selling to the municipality.

And so what some people think of as a large city isn't necessarily one.

The largest cities tend to be the ones in Texas like Houston and Dallas and some of those because they don't have that many people living in high rises, it's spread out more.

Whereas other cities like Atlanta, you would be surprised that they aren't as large as you would think.

That begets another question, Rich.

As you've seen with police departments, fire departments like you've got up in the north shore, Milwaukee has -- they got a whole fire department.

It's not municipal.

It's several municipalities.

Do you see that urbanization -- this other developing?

Or is it strictly one city, one municipal utility?

It is -- we have not seen that developing.

For decades, all I've heard about is the coming consolidation of water utilities and it has not happened.

There has not been the consolidation.

Now -- and the reason people predicted it was because electric and gas, it tends to be consolidated.

Also, sewage tended to be consolidated along the water basins.

It just has not happened in water, and we don't see anything driving it.

And we'll see plenty of signs if it does come because they got to get their police departments, their fire departments and their library systems done before water would ever happen.

Okay.

All right.

And then just final one.

I always laugh at your comments with Chicago, the unaccounted water being unmetered.

It's like horses and carriages.

If you look at the large municipal projects going forward, is it an install of meters for this kind of unmetered unaccountable water?

Or is it primarily with big projects going to be just the conversion to radios and [all]?

Right.

With the big projects, it's going to be primarily radio conversions.

Most of the large cities are metered.

Chicago is kind of an exception, and there are also a lot of unmetered communities in the Central Valley of California, but there are smaller communities too.

So when I'm talking about Detroit's and Miami's, they're metered.

We're talking about the opportunity to sell them radios, but very often with the radios come meter change outs.

And our next question will come from the line of Richard Verdi with Atwater Thornton.

Just a couple of quick questions, primarily pertaining to the President Trump attempt to lower the tax rate.

Kind of wondering, how do you -- how does Badger Meter believe that customers will react in terms of pricing?

Do you think you guys will see some pressure where the customers will want you -- want to reduce prices and see some of that tax benefit pass through?

I don't expect that.

And the reason I say that is, unlike the electric industry, where there are 3,000 or 2,300 electric utilities in the United States and, therefore, there are some very large utilities that have a lot of buying power.

The water utility is very -- the water industry is very fragmented.

There are 51,000 water utilities in the United States, and so you don't have the large ones with a lot of buying power.

And so we haven't seen that in the past.

Generally, pricing pressure in our industry comes from internal rivalry, and I'm kind of quoting Michael Porter's 5 forces.

That's where you -- for you all you MBAs out there.

That's where you see the pricing pressure in our industry.

So if anything, it would be that we would all start competing more aggressively and driving prices down.

I think that's why, when we do a price increase for something like brass, we can get it through.

And then, generally, as brass prices come down, we don't go out and announce a huge price decrease.

Instead, you just start seeing bids and quotes pushing pricing down over a period of time, based on competitive pressures.

That's what really happens in our industry.

That's great.

And then let's just say Badger Meter didn't see any pricing pressure and the company recognized the full benefit of the tax cut.

I mean valuations aren't really right for a buyback.

So could you give us some color on maybe what you guys might do with that benefit?

I mean could it be placed towards acquisitions or R&D or what would be the early thinking?

Yes.

So first off, we would tend to benefit from that more so than some other companies.

And the reason I say that is, if you look at our effective tax rate, it tends to be higher than other companies in our industry, and mainly because we have more of our operations solely in the United States.

And therefore, we tend to pay the higher tax rate.

Companies like Honeywell, which owns Sensus, and -- I'm sorry, Xylem, which owns Sensus.

I said that wrong, okay?

Honeywell, which owns Elster.

They have a large percentage of their operations outside the United States and, therefore, they have a lower tax rate.

So the benefit isn't as great for them.

So let me first point out that, yes, we would tend -- we would stand to benefit more significantly from some of the others.

What we would do is, if we had additional resources, we would definitely want to deploy them and would want to deploy them probably in acquisitions.

That would be our biggest opportunity.

And as I said, we have a desire to get a little more aggressive on acquisitions than we have in the past.

I think the board wanted to be a little more settled on our succession plans going forward before they jumped in on something major.

And now that we've got that better settled, I think we'll be -- you'll see us get a little more aggressive.

Excellent.

And then just a last question, kind of just an easy one here.

I'm sorry if I missed it, but can you just tell me what the business looks like now in terms of new installation versus replacement?

That's always a very hard thing for anybody in our industry to answer.

And the reason is, if I ship 100 meters to the City of Chicago, I don't know how many of those meters are being put into new housing versus being used in replacement.

But having said that, if our industry sells about 6 million meters in the United States a year, and that's probably a reasonable round number, okay.

And if there are a 1.5 million new housing starts in the United States every year.

And let's call it -- let's say, 80% of those new housing starts are on municipal water, 20% are on private wells, you could probably -- you could guess that of the 6 million, maybe a little over 1 million is going into new housing and the 5 million -- a little bit less than 5 million is going into replacement.

Replacement's a higher percentage.

Replacement is a much higher percentage in our industry.

Thank you.

Ladies and gentlemen, this concludes our question-and-answer session for today.

So now it's my pleasure to hand the conference back over to Mr. Rich Meeusen, Chairman, President and CEO, for some closing comments and remarks.

Sir?

Yes.

Thank you, Brian.

And all I'll say is that, obviously, we had a record year last year.

We had 2 record quarters this year.

The third quarter was a little disappointing and the stock price, I always say our stock price tends to overreact on good news and overreact on bad news.

So the stock price has dropped down to a level that we haven't seen, well, since July.

So our stock price is back down to where it was in July.

It had had a significant run-up just in the last couple of months, and it's back down to the July levels.

But we still are very confident about where our business goes in the future.

We don't -- we tend not to focus a lot on the stock price and try to manage that.

We tend to instead manage our business for the long term, and that's our focus.

We think we'll be able to offset this higher brass.

We know we'll be able to offset this higher brass with price increases, which we are working on.

There will be a temporary disruption but the long-term fundamentals of our business are still there, they're still strong and we have a lot of confidence in our ability to continue to generate shareholder value.

So with that, I thank everybody for joining us.

Thank you.

Ladies and gentlemen, thank you for your participation on today's conference.

This does conclude the program, and we may all disconnect.

Everybody, have a wonderful day.